1. BEC 30325: MANAGERIAL ECONOMICS
Session 10
Market Structures Part II
Dr. Sumudu Perera

2. Session Outline Price Discrimination in Monopoly Oligopoly
Sources of Oligopoly
Cournot Model
Kinked Demand Curve Model
Cartels
Price Leadership
Efficiency of Oligopoly
Dr.Sumudu Perera
25/02/201925/02/2019

3. Price Discrimination
Charging different prices for a product when the price differences are not justified by cost differences.
Objective of the firm is to attain higher profits than would be available otherwise.

4. Price Discrimination
1. Firm must be an imperfect competitor (a price maker)
2. Price elasticity must differ for units of the product sold at different prices
3. Firm must be able to segment the market and prevent resale of units across market segments

5. First-Degree Price Discrimination
Each unit is sold at the highest possible price
Firm extracts all of the consumers’ surplus
Firm maximizes total revenue and profit from any quantity sold

6. Second-Degree Price Discrimination
Charging a uniform price per unit for a specific quantity, a lower price per unit for an additional quantity, and so on
Firm extracts part, but not all, of the consumers’ surplus

7. First- and Second-Degree Price Discrimination
If a firm that practices first-degree price discrimination charges $2 and sells 40 units, then total revenue will be equal to $160 and consumers’ surplus will be zero.

8. First- and Second-Degree Price Discrimination
If a firm that practices second-degree price discrimination charges $4 per unit for the first 20 units and $2 per unit for the next 20 units, then total revenue will be equal to $120 and consumers’ surplus will be $40.

9. Third-Degree Price Discrimination
Charging different prices for the same product sold in different markets
Firm maximizes profits by selling a quantity on each market such that the marginal revenue on each market is equal to the marginal cost of production

10. Third-Degree Price Discrimination

11. Oligopoly Few sellers of a product Nonprice competition
Barriers to entry
Duopoly - Two sellers
Pure oligopoly - Homogeneous product
Differentiated oligopoly - Differentiated product

12. Sources of Oligopoly Economies of scale
Large capital investment required
Patented production processes
Brand loyalty
Control of a raw material or resource
Government franchise
Limit pricing

13. Cournot Model Proposed by Augustin Cournot Behavioral assumption
Firms maximize profits under the assumption that market rivals will not change their rates of production.
Bertrand Model
Firms assume that their market rivals will not change their prices.

14. Cournot Model Example Two firms (duopoly) Identical products
Marginal cost is zero
Initially Firm A has a monopoly and then Firm B enters the market

15. Cournot Model Adjustment process
Entry by Firm B reduces the demand for Firm A’s product
Firm A reacts by reducing output, which increases demand for Firm B’s product
Firm B reacts by increasing output, which reduces demand for Firm A’s product
Firm A then reduces output further
This continues until equilibrium is attained

16. Kinked Demand Curve Model
Proposed by Paul Sweezy
If an oligopolist raises price, other firms will not follow, so demand will be elastic
If an oligopolist lowers price, other firms will follow, so demand will be inelastic
Implication is that demand curve will be kinked, MR will have a discontinuity, and oligopolists will not change price when marginal cost changes

17. Kinked Demand Curve Model

18. Cartels Collusion Market-Sharing Cartel Centralized Cartel
Cooperation among firms to restrict competition in order to increase profits
Market-Sharing Cartel
Collusion to divide up markets
Centralized Cartel
Formal agreement among member firms to set a monopoly price and restrict output
Incentive to cheat

19. Price Leadership Implicit Collusion Price Leader (Barometric Firm)
Largest, dominant, or lowest cost firm in the industry
Demand curve is defined as the market demand curve less supply by the followers
Followers
Take market price as given and behave as perfect competitors

20. Price Leadership

21. Efficiency of Oligopoly
Price is usually greater then long-run average cost (LAC)
Quantity produced usually does correspond to minimum LAC
Price is usually greater than long-run marginal cost (LMC)
When a differentiated product is produced, too much may be spent on advertising and model changes